The Tension of Risk-On vs Risk-Off

Understanding these two terms is critical once again. Risk-on is when investors take more risk, buying higher-risk stocks and selling bonds and gold. Risk-off is when investors become more risk averse, selling stocks and buying bonds and gold.

Risk-on is what’s happening now. The election of Trump has suddenly convinced investors that the economy is going into a period of higher economic growth and higher inflation. Investors are mobilizing their money and credit to buy stocks, particularly junior stocks and companies that supposedly could benefit from a Trump economy…such as construction, military contracting and ‘inflation plays’ including some commodities. Bonds and gold have been sold hard and money is leaving the developing economies to return home to what is expected to be a U.S. economic miracle, resulting in a stronger dollar. Expectations are that the Fed will now have to be more aggressive in its monetary policy which has also boosted the dollar.

In fact, I think that risks are rising, not falling, but that’s not what the markets think and there is no point arguing with an ongoing train until it derails. And it will derail. Although Trump’s victory is an immense change in the political sphere, it changes virtually nothing in the financial and economic spheres, where risks continue to mount. I caution you with this warning: All the good news from the election is already in the market. Now we will begin to see the problems.

As Morgan Stanley points out, we don’t even know what the Trump economic plan is. If it involves ripping up trade deals and declaring China to be a currency manipulator, his policies could do much more harm than good. A tax reduction without spending cuts will drive the deficit and the national debt load higher at a time when interest rates are rising, putting additional strains on debt markets and investor confidence. Furthermore, nothing is going to happen overnight. It will take years to get the Trump economic plan implemented.

Those commentators euphorically calling for real growth in the U.S. of 4% fail to understand that growth depends on three factors…credit growth, productivity growth and working age population growth. All three are in decline and will take many years to reverse. As Ray Dalio points out, the world is at the end of a credit cycle with governments, corporations and consumers all loaded up with historically high levels of debt. Productivity growth is at historic lows as businesses have cut back investment over the past decade, instead funding financial engineering. The world’s working population is aging and there are now far more workers looking to retire and leave the labor force rather than join it and pay taxes.

What are the risks? First and foremost, debt markets are way overextended in quantity and price at the same time that interest rates are soaring. Let’s remember how the stock market got to these valuations…cheap money and lots of it. Money is now much more expensive than it was a very short period of time ago. Since early July, the 10-year yield has jumped by 87 basis points. The 30-year yield has risen 83 basis points since early July, reflecting a 13% plunge in price during that time. These are enormous moves in the world’s largest and deepest market which acts as a benchmark for every other security on the planet. Higher rates are not going to help an economy burdened with too much debt that is already slowing down along with the rest of the globe.

Second on my list is the EU banking system which is drowning in non-performing loans, too little capital and declining liquidity despite enormous stimulus from the European Central Bank. Meanwhile, there are important elections coming up next month in Austria and Italy that threaten the political stability of Europe.

The Chinese Yuan is collapsing in tandem with falling trade and production figures amid the biggest credit boom in history.

My sense is that this period of risk-on will not last long and then we will see what the world really looks like. I’m guessing it will be very gold friendly.

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Who is Wayne Wile?

Wayne Wile is an international investment advisor with more than five decades of experience in wealth management. He has spent the majority of his career working with institutional and high net worth investors, seeking to mitigate risk while optimizing portfolio performance.

Wayne began work in the mailroom of a brokerage firm when he was 17 years of age and rose to a senior executive position. He was recruited for key jobs with several nationally recognized investment firms in Canada before striking out on his own.

Wayne’s methods as a trader are governed by simplicity and self-discipline. He says that losses are the children of greed and fear while profits are the spawn of patience and trend-following. “Time is always on your side. Let the market tell you what it wants to do and keep it company. Never chase an idea you think you have missed. There is always another one coming along.”

Wayne is especially opposed to sophisticated trading strategies that try to predict the future based on mathematical analysis of historical data. “These systems routinely destroy far more wealth than they create,” he says. “Only a highly intelligent, well-educated individual would be foolish enough to do this stuff. Successful traders need to stop analyzing and learn to listen to what the market is telling them every day.”

Wayne resides in the Cayman Islands but considers himself a citizen of the world.